There are not many certainties in life, except that night follows day and Scotland will lose the rugby at Twickenham.
We could add three certainties to top slicing relief for insurance bonds: the difference in higher-rate tax between the full gain and the slices; that higher-rate taxpayers did not benefit; and that everyone worked it out the ‘short way’.
But, as evidenced by Scotland’s remarkable Calcutta Cup comeback, these certainties are no more. Changes to the insurance policyholder taxation manual at the tail end of 2018, linked to the introduction of the personal savings allowance, have meant top slicing has changed for good. It can also bring the £5,000 band of starting rate for savings into play.
It is worth reminding ourselves how things used to work. HM Revenue & Customs (HMRC) had a six-step process to work out the relief.
Step one: Add the total gain onto the individual’s total income and calculate how much of this falls into the higher-rate tax band. If all of the gain falls in the basic rate band, or the higher band, no top slicing relief is due and steps two to six are not needed.
Step two: Calculate the step two liability, which is simply the step one amount of gain falling into the higher-rate tax band x 20% (the difference between the higher and basic rate tax).
Step three: Calculate the ‘annual equivalent’ of the gain by dividing it by N (the slice).
Step four: Add the total annual equivalent onto the individual’s total income. How much of this falls into the higher-rate tax band?
Step five: Calculate the step five liability by using the same process as step two. First, find the amount of annual equivalent falling into the higher rate tax band x 20% (40% - 20%), then multiply this amount of tax by N.
Step six: The amount of top slicing relief is the step two liability minus the step five liability.
Not many people started that six-step process as the short method (almost always) sufficed. But now the short method will not work and higher-rate taxpayers may get top slicing relief.
The fundamental change is that top slicing relief is based on the difference in total tax on the full gain and the slices instead of just the amounts in the higher-rate tax band.
HMRC’s new five-step process is as follows:
Step one: Calculate the total taxable income for the year and identify how much of the gain falls within the starting rate for savings, personal savings allowance nil-rate, basic, higher or additional rate bands as appropriate.
Step two: Calculate the total tax due on the gain across all tax bands. Deduct basic-rate tax treated as paid to find the individual’s liability for the tax year.
Step three: Calculate the annual equivalent of the gain. The annual equivalent is calculated by dividing the gain by N.
Step four: Calculate the individual’s liability to tax on the annual equivalent. The amount of the savings starting rate and personal savings allowance used in the top slicing relief calculation are set by virtue of the taxpayer’s adjusted net income for the tax year. They are not adjusted to calculate the notional tax due on the ‘sliced gain’. Deduct basic rate tax treated as paid on the annual equivalent and multiply the result by N. This gives the individual’s relieved liability.
Step five: Deduct the individual’s relieved liability at step four from the individual’s liability at step two to give the amount of top slicing relief due.
The process is identical for onshore and offshore bond gains. What the change has done is ensure taxpayers benefit from any available personal savings allowance and to a lesser degree, starting rate for savings.
Interestingly, the new method effectively gives the benefit of multiple personal savings allowances and, albeit less likely, a starting rate for savings when determining the amount of top slicing relief.
Les Cameron is head of technical at Prudential